ILJIN Materials (KRX:020150) Takes On Some Risk With Its Use Of Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies ILJIN Materials Co., Ltd. (KRX:020150) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for ILJIN Materials

What Is ILJIN Materials's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 ILJIN Materials had debt of ₩49.5b, up from ₩8.18b in one year. But it also has ₩312.5b in cash to offset that, meaning it has ₩263.1b net cash.

How Healthy Is ILJIN Materials' Balance Sheet?

The latest balance sheet data shows that ILJIN Materials had liabilities of ₩100.7b due within a year, and liabilities of ₩112.6b falling due after that. On the other hand, it had cash of ₩312.5b and ₩101.7b worth of receivables due within a year. So it actually has ₩201.0b more liquid assets than total liabilities.

This short term liquidity is a sign that ILJIN Materials could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, ILJIN Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for ILJIN Materials if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if ILJIN Materials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While ILJIN Materials has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, ILJIN Materials burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that ILJIN Materials has net cash of ₩263.1b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about ILJIN Materials's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for ILJIN Materials you should be aware of, and 1 of them can't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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